Pension risk: implications for banks' risk management (with emphasis on UK)

The proper functioning of occupational pension schemes is critically important for economies and the financial sector in which they operate. Financial institutions with meaningful pension exposures are obliged to undertake proper management of their pension responsibilities in order to mitigate untoward effects on the economy and society. This paper seeks to explore how banks in particular, with an emphasis on the UK environment, can and should mitigate their pension exposures. It reviews the main types of pension schemes and related regulation of these, examines the key drivers of pension risk on banks' balance sheets, and discovers the implications for bank liquidity risk, utilising a case study. Based on these practical observations, the paper goes on to recommend an appropriate pension risk framework, along with related capital management strategies. It concludes with consideration of the treatment of pension risk obligations in the Internal Capital Adequacy Assessment Process (ICAAP) of sponsoring banks.